Macro volatility in a model of the UK Gilt edged bond market

This paper develops an arbitrage-free macroeconomic model of the yield curve and uses this to explain the behaviour of the UK Treasury bond market. Unlike previous models of this type, which assume a homoscedastic error process I develop a general affine model which allows volatility to be conditioned by the level of inflation (and possibly other macroeconomic variables). In my preferred empirical specification conditional volatility and risk premia are affine in the level of inflation. I test this model against more general specifications in which the risk premia also depend upon interest rate and other macro variables, but find little evidence of these wider effects. The resulting specification provides a parsimonious explanation of the behaviour of the UK yield curve, keying it in to the behaviour of the macroeconomy.Times series models, Affine term structure model, macroeconomic factors, monetary policy

UK macroeconomic volatility and the term structure of interest rates.

This paper uses a macro-finance model to examine the ability of the gilt market to predict fluctuations in macroeconomic volatility. The econometric model is a development of the standard ‘square root’ volatility model, but unlike the conventional term structure speci…cation it allows for separate volatility and in‡ation trends. It finds that although volatility and inflation trends move independently in the short run, they are cointegrated. Bond yields provide useful information about macroeconomic volatility, but a better indicator can be developed by combining this with macroeconomic information.

Stochastic Volatility in a Macro-Finance Model of the US Term Structure of Interest Rates 1961-2004.

This paper generalizes the standard homoscedastic macro-finance model by allowing for stochastic volatility, using the ‘square root’ specification of the mainstreamfinance literature. Empirically, this specification dominates the standard model because it is consistent with the square root volatility found in macroeconomic time series. Thus it establishes an important connection between the stochastic volatility of the mainstream finance model and macroeconomic volatility of the Okun (1971) - Friedman (1977) type. This research opens the way to a richer specification of both macroeconomic and term structure models, incorporating the best features of both macro-finance and mainstream-finance models.Macro-finance, affine term structure, heteroscedasticity

Affine Macroeconomic Models of the Term Structure of Interest Rates: The US Treasury Market 1961-99

This paper develops a macroeconomic model of the yield curve and uses this to explain the behaviour of the US Treasury market. Unlike previous macro-finance models which assume a homoscedastic error process, I develop a general affine model which allows volatility to be conditioned by interest rates and other macroeconomic variables. Despite the extensive use of stochastic volatility models in mainstream finance papers and the overwhelming evidence of heteroscedasticity in macroeconomic and asset price data this is the first macro-finance model of the bond market with this feature. My preferred empirical specification uses a single conditioning factor and is thus the macro-finance analogue of the EA1 (N) specification of the mainstream finance literature. This model performs well in encompassing tests that lead to a decisive rejection of the standard EA0(N) macro-finance specification. The resulting specification provides a flexible 10-factor explanation of the behaviour of the US yield curve, keying it in to the behaviour of the macroeconomy.

A Wave-Mechanical Approach to Cosmic Structure Formation

The dynamical equations describing the evolution of a self-gravitating fluid can be rewritten in the form of a Schrodinger equation coupled to a Poisson equation determining the gravitational potential. This wave-mechanical representation allows an approach to cosmological gravitational instability that has numerous advantages over standard fluid-based methods. We explore the usefulness of the Schrodinger approach by applying it to a number of simple examples of self-gravitating systems in the weakly non-linear regime. We show that consistent description of a cold self-gravitating fluid requires an extra "quantum pressure" term to be added to the usual Schrodinger equation and we give examples of the effect of this term on the development of gravitational instability. We also show how the simple wave equation can be modified by the addition of a non-linear term to incorporate the effects of gas pressure described by a polytropic equation-of-state.Comment: 9 pages, 2 figures. Minor changes. Accepted for publication in MNRA

An open-economy macro-finance model of international interdependence : The OECD, US and the UK

This paper develops a multi-country macro-finance model to study international economic and financial linkages. This approach models the economy and financial markets jointly using both types of data to throw light on such issues. The world economy is modelled using data for the US and aggregate OECD economies as well as the US Treasury bond market using latent variables to represent a common inflation trend and a US real interest rate factor. We find strong evidence of global effects on both the US and UK, calling into question the standard closed economy macro-finance specification. These economic linkages also help to explain the co-movement of yields in the US and UK Treasury bond markets. (C) 2009 Elsevier B.V. All rights reserved

UK Macroeconomic Volatility and the Welfare Costs of Inflation

This paper explores the implications of time varying volatility for optimal monetary policy and the measurement of welfare costs. We show how macroeconomic models with linear and quadratic state dependence in their variance structure can be used for the analysis of optimal policy within the framework of an optimal linear regulator problem. We use this framework to study optimal monetary policy under inflation conditional volatility and find that the quadratic component of the variance makes policy more responsive to inflation shocks in the same way that an increase in the welfare weight attached to inflation does, while the linear component reduces the steady state rate of inflation. Empirical results for the period 1979-2010 underline the statistical significance of inflation-dependent UK macroeconomic volatility. Analysis of the welfare losses associated with inflation and macroeconomic volatility shows that the conventional homoskedastic model seriously underestimates both the welfare costs of in‡ation and the potential gains from policy optimization.Monetary policy, Macroeconomic volatility, Optimal control, Welfare costs of inflation.

Assessing the Relation between Equity Risk Premia and Macroeconomic Volatilities

In this paper, we used modified multivariate EGARCH-M models to assess the relation between the equity risk premium, macroeconomic risk, and inflationary expectations. To rationalise this link between equity risk premia and macroeconomic volatilities, we built our empirical study on the stochastic discount factor (SDF) model. As an innovative feature of our empirical model, we used long-term government bond yields in order to explain this risk-return relation. Our research suggests that stock market investors should use long-term government bond yield for the UK and term spread for the US in order to instrument their assessment of stock market investment opportunities and riskiness. We also document that the relevance of the short-term interest rates has decreased over the last decade, whereas the relevance of the long-term government bond yields, by contrast, has increased. With regard to the risk-return relation, we found the UK investors tend to significantly price in inflation risk premia. Estimation results strongly suggest that the decline in macroeconomic volatilities might have played an increasingly important role in reducing risk premia in the US and, to some extent, in the UKAsset pricing, Risk premium, Macroeconomic volatility, Stochastic discount factor model, Multivariate EGARCH-M model

An Open-Economy Macro-Finance Model of Internatinal Interdependence: The OECD, US and the UK.

This paper develops a multi-country macro-finance model to study international economic and financial linkages. This approach models economic and financial variables jointly using both to throw light on such issues. The world economy is modelled using data for the US and aggregate OECD economies as well as the US Treasury bond market, using latent variables to represent a common inflation trend and a US real interest rate factor. We find strong evidence of OECD effects on the US, calling into question the standard closed economy macro-finance specification. The two global latent variables also affect the UK economy, together with two additional UK-specific latent variables. These economic linkages also help to explain the comovement of yields in the US and UK Treasury bond markets.macroeconomics, spillover effects, common shocks, macro-finance model, the term structure of interest rates